• Gold: Is It Just Another Commodity?

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    It’s one
    thing to invest in gold. It’s another to understand the logic
    of gold in a free economy. You should do both. But understanding
    the economic logic of is more important than investing in gold.

    One of my
    goals is to make the economics of gold clearer to people. If you
    don’t understand why I recommend gold as an investment, you may
    decide to buy gold just because you take my word for it. Don’t
    do this. Buy gold or gold-related investments such as North American
    gold shares only when you understand the economics behind gold.

    Four decades
    ago, the Foundation for Economic Education (FEE), published a
    series of essays that were later assembled into a book, Clichés
    of Socialism. (It was later updated as Clichés
    of Politics
    .) They were standard accusations against the
    free market. They were wrong-headed, but initially they sounded
    plausible. One by one, these essays refuted them.

    I think it’s
    worthwhile to assemble a few of the standard clichés against
    gold, and then offer answers.

    Clich
    #1: "Gold Is Just Another Commodity"

    This is the
    equivalent of saying "Warren Buffett is just another stock
    market investor." In my day (and, I would argue, still),
    it would have been like saying, "Sophia Loren is just another
    woman." Or, in 1990, "Michael Jordan is just another
    basketball player."

    Gold is a
    commodity. That’s why it has functioned as money for thousands
    of years. Ludwig von Mises argued in his book, The
    Theory of Money and Credit
    (1912) that money is the most
    marketable commodity. This is another way of saying that money
    is the most liquid asset.

    Liquidity
    consists of the following:

    1. Instant sale without offering a discount

    2. Instant sale without advertising costs

    3. Instant sale without paying a commission

    Historically,
    gold functioned as money. It no longer does. Gold is not liquid
    any longer. The general public has gotten used to credit money
    issued by banks. It is used to pieces of paper with dead politicians’
    pictures on them (United States) or live politicians’ pictures
    (Third World countries), or a missing politician’s picture (Iraq).

    But until
    World War I led to the universal confiscation of depositors’ gold
    by commercial banks, followed by the gold’s confiscation from
    the commercial banks by the central banks, gold was money.

    Why? Because
    gold had four crucial characteristics:

    1. Divisibility

    2. Transportability

    3. Recognizability

    4. High value in relation to volume and weight

    Silver also
    possesses these features, but it has lower value in relation to
    volume and weight. It was used for smaller transactions.

    Here is the
    ultimate fact of gold as money: it is cheaper to print pieces
    of paper than it is to mine gold. It is easier still to create
    digits in a computer.

    OTHER
    COMMODITIES

    Most other
    commodities are consumed in use. Gold, in its monetary function,
    is not consumed. Most of the world’s above-ground gold is in vaults.
    It is used in exchange, but it is not used up.

    Most other
    commodities wear out. Gold doesn’t. It doesn’t tarnish. An acid,
    aqua regia, destroys it, but nothing else does. Gold coins and
    bars at the bottom of the ocean can be salvaged and instantly
    put back into the economy. There is a ready market for these coins.

    Most other
    commodities are not the objects of nearly universal demand. The
    Spanish conquistadores found that gold was highly prized by the
    monarchs of the Indian empires in Mexico and South America.

    Most other
    commodities do not have a "track record" of thousands
    of years. Gold does. It has been in high demand for as long as
    societies based on extensive trade have left records.

    Most other
    commodities have not been political metals. Gold has. This is
    why the Roman emperors put their images and slogans on the empire’s
    coins.

    Nobody says,
    "it’s as good as copper," let alone "it’s as good
    as pork bellies."

    The Bible
    says, "And Abram was very rich in cattle, in silver, and
    in gold" (Genesis 13:2). It did not mention platinum. As
    for the Bible’s assessment of the value of wisdom,

    But where
    shall wisdom be found? and where is the place of understanding?
    Man knoweth not the price thereof; neither is it found in the
    land of the living. The depth saith, It is not in me: and the
    sea saith, It is not with me. It cannot be gotten for gold,
    neither shall silver be weighed for the price thereof. It cannot
    be valued with the gold of Ophir, with the precious onyx, or
    the sapphire. The gold and the crystal cannot equal it: and
    the exchange of it shall not be for jewels of fine gold (Job
    28:12—17).

    Not one reference
    to soybean oil!

    A SPECIAL
    COMMODITY

    Gold is used
    as jewelry. It is used for ornaments of great value. It is used
    in art, especially religious art. It is associated with God in
    many religions, probably because of the characteristics already
    mentioned, plus this one: it’s brightness and color. It is associated
    with the sun, just as silver is associated with the moon.

    This explains
    why gold and silver became money. Both metals were highly valued
    for reasons other than their use in exchange. They became valuable
    in exchange because they possessed value prior to their circulation
    as money. This was the insight of Professor Mises, his "regression
    theorem" of money. This is why money was created by the market
    itself, not by kings.

    When used
    as money, gold extended the market across borders. People on both
    sides of a border desired gold, irrespective of the image on the
    bar or coin (after 700 B.C.). It could be melted down and re-cast.
    Someone else’s image could be stamped on it.

    Additional
    voluntary exchanges became possible because there was a ready
    market for gold. Thus, because gold was not just another commodity,
    it facilitated the extension of the division of labor. Men’s productivity
    rose because they could specialize in their work. They got better
    at whatever it was that they did for a living.

    CENTRAL
    BANKERS’ MONEY

    If gold is
    just another commodity, why do the world’s central bankers use
    it to settle final accounts? Why aren’t bars of some other commodity
    stored in the vault of the Federal Reserve Bank of New York? Why
    didn’t they make "Diehard III" about a heist of, say,
    hard red winter wheat?

    Central bankers
    don’t trust each other. They know how easy it is to create money
    out of nothing. They hold dollar-denominated assets, such as U.S.
    Treasury-bills, because they can earn interest — not much these
    days — but they settle their final accounts with each other in
    gold.

    If gold were
    just another commodity, there would be greater flexibility in
    settling accounts. They could choose a different commodity. But
    they choose gold. They did throughout the 20th century,
    even during World War II. That’s why they created the Bank for
    International Settlements in Basle, Switzerland. Western and Nazi
    bankers met with each other because each side knew that without
    a money economy, it could not win the war. Gold is the base of
    the money economy in international trade.

    There is
    talk about replacing the dollar with some other currency as the
    unit of account, i.e., the world’s reserve currency. But in the
    final settlements, gold is the world’s reserve currency. For central
    bankers gold is money. It has liquidity.

    A RETURN
    TO GOLD

    Gold bugs
    believe that there will be a voluntary return to the use of gold
    by the general public. The computerized technology now exists
    to create private money systems based on gold — digital gold. There
    can be 100% reserve banking. The digits allow us to make exchanges
    in the range of one dollar’s purchasing power.

    This doesn’t
    mean that the public will necessarily adopt "gold cards,"
    i.e., debit cards in gold — to conduct their common economic
    affairs. It will probably take a breakdown of the present debt-based
    monetary system to persuade the average Joe or Mitsuo to make
    the switch. The problem is, such a breakdown could involve the
    destruction of the entire credit system and therefore the exchange
    system, i.e., a vast contraction of the economy, which would drastically
    shrink the division of labor and with it, specialization of production.
    This would involve gridlock: Bank A could not settle accounts
    with Bank B until Banks C and D settled with Bank A. Greenspan
    calls this disaster "cascading cross defaults."

    http://www.federalreserve.gov/boarddocs/testimony/1998/19981001.htm

    Perhaps a
    major country, such as China, will restore currency convertibility
    into gold. This would surely make China’s currency the world’s
    new reserve currency. But it would place people at risk, since
    the government could suspend convertibility at any time. This
    is what governments invariably do when gold runs begin.

    I do not
    expect a return to a gold coin standard in my lifetime, but I
    do expect it eventually. The free market can offer a better product
    than any government can. This is as true of money as it is of
    any other mass-produced product. The money of preference historically
    has been a commodity, and gold has been the favored commodity
    for large transactions. Silver and copper are in second and third
    place, respectively.

    CONCLUSION

    Anyone who
    says that gold is just another commodity is ignorant of the history
    of money. He is spouting a cliché, not making an argument.

    September
    19, 2003

    Gary
    North is the author of Mises
    on Money
    . Visit http://www.freebooks.com.
    For a free subscription to Gary North’s newsletter on gold, click
    here
    .

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